Classical vs Modern Monetary Theory

Classical vs Modern Monetary Theory

I am intrigued that both Classical Monetary Theory (CMT) and Modern Monetary Theory (MMT) have a way of explaining how macroeconomics works, yet both think the other theory is wrong, while their own theory is right.  

I think it is generally agreed that it is bad to let a sovereign currency inflate, i.e. devalue. It is tantamount to stealing from anyone who holds cash in that currency. It is embarrassing and to be avoided. But deflation is also to be avoided. It seems there is an international consensus that a currency should inflate, but only by a steady 2% per annum. 

CMT believes that a thrifty, well run country should not run a deficit but should raise in taxation as much money as its government spends.  If there is a deficit, CMT believes that printing money, or simply writing it into existence, causes inflation –– at least, in the absence of growth in the economy.  For it believes that the value of a currency is a simple but inexorable function of the total quantity of 'Goods' divided by the total quantity of 'Money'.  The preferred CMT response to a deficit is to borrow on the international bond market. But the CMT economists warn that too much borrowing will 'spook' the markets and interest rates will go up. The country will find itself stretched over a barrel as more and more of our tax goes straight off to pay interest on our National Debt. Were inflation to occur, the Bank of England would raise interest rates, which inhibits the economy. That would curb spending by the poorer (indebted) citizens while cushioning (or even rewarding) the better-off lenders.

MMT believes that deficits are vital if the economy is to grow, as it is the only way that money (currency) can enter the private sector. MMT holds that taxes are not required to "pay for government", for there is no reason why the money cannot be created (by a sovereign government; provided that it does not cause inflation). If there is idle capacity in the economy, printing money should stimulate the economy. If the economy is at full employment and surplus money is still chasing goods and services there will be inflation. The MMT answer to inflation is to raise taxes (rather than interest rates). This takes money off those that have it (rather than those that do not have it). Taxes can have other beneficial effects besides reducing demand for goods; it can reduce inequality, and it can reduce e.g. smoking or carbon dioxide emission.

Where CMT thinks that the value of a currency is set by the ratio of the total quantity of 'Money' (defined narrowly, or broadly?) to the total quantity of 'Goods', it could be argued that prices are set much more locally, by people who know neither the total quantity of 'Money', nor of 'Goods'; prices even respond to 'expectations'. Look at the way BP's profits soared when the Iranians closed the Strait of Hormuz. Perhaps the biggest difference between the two theories is in the different ways in which they propose to handle inflation. Though both schools aim to reduce the local availability of money, the CMT school would raise interest rates, inhibiting business and penalising the indebted, while the MMT school would raise taxes. 

TAX: good or bad

 TAX: GOOD OR BAD FOR THE AVERAGE TAXPAYER?

Of course taxes lower our take-home pay; no question. But, equally obviously, taxes fund the many services that central government provides.  Are taxes, then, a good thing or a bad thing? And why did all the candidates for the post of Tory party leader promise to degrade further our public services?

The better-off pay more tax than the less-well-off, and, because of the 'progressive' tax system in the UK, the tax-rate is higher for the rich than for the poor. 

There must be an annual salary above which the paying of due taxes will render a citizen poorer (in that the benefits he enjoys cost less than the tax he pays), while below that annual salary the due taxes will amount to less than the benefits (roads, education, police, health).  What is that pivotal annual salary? And why do so many people think they are net contributors, when at least half the population are likely to be net beneficiaries?

Imagine a see-saw pivoted at the 'median' annual income, with the rich to the right side and the poor to the left side. It will balance, as that is the definition of the median (There are as many individuals earning more than the median as there are earning less.)

Now let them sit on the see-saw with their money; it will clearly tip to the right, because the rich have more money than the poor. In fact, if the incomes alone are weighed, the see-saw will balance at the ‘arithmetic mean’ income.

 (See Figure 1; data from ONS, Average household gross income, UK: financial year ending 2021. The “equivalised median” is said to be £37,900; the “equivalised mean” £48,700)  

Some of those people earning more than £48,700 per annum gross (or £37,000 after tax) might rationally think they would benefit from lower taxes (not-withstanding the consequently deteriorating services: congested bumpy roads, decaying infrastructure, sick population, etc..)

But I cannot think why anyone whose gross annual income is less than £48,700. would vote for lower taxes.  We should logically vote for increased taxes and improved services.

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 “The ‘equivalised’ disposable income is calculated in three steps: all monetary incomes received from any source by each member of a household are added up; these include income from work, investment and social benefits, plus any other household income; taxes and social contributions that have been paid, are deducted from this sum; in order to reflect differences in a household's size and composition, the total (net) household income is divided by the number of 'equivalent adults’, using a standard (equivalence) scale: the modified OECD scale; this scale gives a weight to all members of the household (and then adds these up to arrive at the equivalised household size): 1.0 to the first adult; 0.5 to the second and each subsequent person aged 14 and over; 0.3 to each child aged under 14. Finally, the resulting figure is called the equivalised disposable income and is attributed equally to each member of the household.”

Comments, please, to: cawstein@gmail.com

 Tax Fat Cars

I think the government should think about putting a tax on extra-wide cars. It might turn the trend away from ever-wider and wider models, which would save an awful lot of bother and expense, and at the same time raise a little revenue to pay for the damage done to our roads. 

Fat cars are as much of a nuisance in a carpark as they are in a narrow lane; for their owners as well as for everyone else. And in a subtle but undeniable way they are somewhat insulting to the 'ordinary' person (who is content with an 'ordinary' sized car). Only by driving with extreme humility can a fat car owner avoid the implication that he or she thinks they are 1½ times as important as their fellow road users. The wives sometimes manage it, by looking helplessly lost in the great space of the interior, while they grip the great wheel and peer over the dashboard, slowing to nothing as they approach another road-user. But the husbands seldom try, preferring to display their road-skills, and panache.

Of course, cars are getting bigger and heavier because they incorporate ever higher safety standards; as is pointed out by Richard Bremner in the August 2019 number of Autocar (https://www.autocar.co.uk/car-news/features/investigation-why-are-cars-becoming-so-wide). But I am not talking about the merely-wide; rather the too-wide, and the unnecessarily-wide.

Cars that are over 2 metres wide automatically fall in this category. But I think it would be fair to bring the road-fund 'super-tax' in at 1990 mm.

Car                                                    Width (mm)

Landrover Rangerover sport                1990

Audi Q8                                                1995

Landrover Defender (90/110)              1996

Bentley Bentayga                                 2010

Landrover Discovery (mirrors out)      2220

You see, I am thinking of the inconvenience to fellow road users, as well as the damage to our roads. It is bad enough when a wide car meets a normal car. But as the frequency of these giants increases every year, there will come the time when a fat car meets another fat car. Something has to give. Richard Bremner recounts a London traffic jam caused simply by the fact that a Bentley Continental GT and a Range Rover were unable to pass one another in an ordinary street. The resulting jam took 20 minutes to clear. 

If the verges are soft, it is the verges that have to give. Think of the cost to the public purse of repairing or widening the 214,900 miles of minor roads that we have in Britain. If we cannot halt the trend towards wider cars, we can at least start to put money aside to repair the damage.

(See also: https://occidentis.blogspot.com/2012/04/higher-tax-bands.html
https://occidentis.blogspot.com/2016/09/estate-tax-and-limits-to-wealth.html
https://occidentis.blogspot.com/2018/04/government-spending_2.html
https://occidentis.blogspot.com/2012/03/budget-2012.html
https://occidentis.blogspot.com/2012/11/positive-money.html
https://occidentis.blogspot.com/2013/03/the-money-masters-positive-money.html
https://occidentis.blogspot.com/2012/11/positive-money-2.html
https://occidentis.blogspot.com/2014/07/monetarism-1.html
https://occidentis.blogspot.com/2016/10/why-tax-why-not-just-print-money.html
https://occidentis.blogspot.com/2019/07/bank-capitalisation.html
https://occidentis.blogspot.com/2011/10/deficit-spending_11.html)

Paying Taxes -- both a virtue and a necessity

 Why pay tax? 

    It is amazing how many people in Britain think taxes are wrong and should be avoided where possible. 

    Nevertheless, I was slightly surprised the other Sunday when the subject cropped up over a pre-prandial pint in the Greatworth Inn. My friend 'the accountant' said he thought that death duties were wrong; that they amounted to double taxation and little different from plain theft. 

    "Maybe", I said, "but still necessary", for I saw an opportunity to lay out my favourite recent aperçu.

 

    (Apparently it takes a certain sort of intelligence to realise that there are benefits that accrue from taxation: railways, roads, bridges, medicines, the disposal of waste, safety from violence, etc. Some rare citizens even wince at the sight of poverty in the streets. Many can be cajoled into paying taxes by ensuring that all people pay them in some sort of 'fair proportion'. But defining and ensuring fairness is far more easily said than done.  A few years back I crossed swords with a 5th Viscount over the existence of 'altruism' in human populations, which he pooh-poohed . 

    "What about in the paying of taxes?" I had said. 

    "But we do not pay taxes willingly" he objected. 

    "Of course we pay them willingly", I expostulated. "That is to say, a majority of MPs in the house of Commons voted through all the relevant legislation."  The Viscount turned then to other questions, and I was left with the distinct feeling I had routed him.)

    "Have you noticed," I said, returning to my accountant friend and my recent aperçu, "how money continuously flows from poor people to rich people, steadily and inevitably; taxes are needed to return money to the poor so the process can continue." 

    This is a novel idea, for even quite poor people think of tax as a net loss rather than a net gain, which to them it clearly is. 

    "But, but, but !!! " he protested; "The large incomes of the rich are the result of market forces; it is earned income; the money belongs to the rich by right; they are paid well because they are worth it."

    "All that may be true", I replied; "but it still has to be returned to the poor. It is the accumulation in the hands of the rich that has to be prevented. If the rich spent their income properly, that is to say fully, the inequality might be better tolerated. But they hoard their wealth. And so it must be prised out of their clenched fists." 

    Silence fell.

    "Who is for another beer?"  I offered, for I realised my companions were not up for radically rethinking taxation, and I could see another aperçu coming towards me: "What is a fair tax regime?  It must clearly be a tax regime that prevents the rich from getting richer, and the poor from getting poorer."

    Rather neat, do n't you think, for a Sunday morning?  Death duties are obviously the best way of collecting what must be collected; for only then is it clear how much is involved. (See also: https://occidentis.blogspot.com/2016/09/estate-tax-and-limits-to-wealth.html)

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Tuition Fees

Tuition Fees

"The media's favourite blunder: Yacht-owners are (on average) rich; but I strongly advise against buying a yacht in the hope of becoming rich. "

    Our coalition government has welcomed the Browne Report's recommendations on funding universities in England. The suggestion is that universities will lose a chunk of central funding but a can charge students as high a fee as they need to make good the loss (figures of £6000 - £7000 per annum have been mentioned); that students borrow the £21,000 - 36,000 odd needed to get them through their 3 year degree (accommodation plus tuition); that this debt immediately attracts commercial rates of interest (2.2% above inflation); payback commences when the graduates earns more than £21,000 p.a. and continues as the rate of 9% of income for the next 30 years, if necessary. [See the helpful briefing by the Institute for Fiscal Studies: http://www.ifs.org.uk/pr/browne_review.pdf]

    There seems to be a lot of nonsense written about this matter and I propose to add my twopennyworth here.

    First, "If it is not broken, don't fix it!". Higher education was funded in my day out of taxes (on a means-tested basis) on the grounds that it was of benefit, not merely to the recipient, but to the nation. That system worked for many years, but maybe it does not now, for many reason(s). [a] There has been a grotesque expansion of the university sector. [b] Politicians are squeamish about putting 2% on income tax to pay for it. [c] The "fairness" argument has suggested that the beneficiaries are the graduates themselves, forgetting the benefit to the rest of society. (A point to which I shall return, below.)

    It has been pointed out by the media that graduates earn (on average) some £100,000 more than non-graduates in a lifetime, as though this might justify spending £36,000 at the beginning of your adult life — as an investment. But might this not be another instance of the media's favourite blunder? Yacht-owners are (on average) rich; but I strongly advise you not to buy a yacht in the hope of becoming rich. I am a great advocte of education, as a means of improving society, but not as a means of becoming rich. I (who have taught at universities for > 30 years) think at least 50% of degrees contribute little or nothing to the wealth of the graduate, nor to GNP. Even if your school-leaver decided to spend £36,000 as an investment, it seems a very poor one (on average). The FTSE 100 index began on 3 January 1984 at 1,000 and now stands at 5,700; £36,000 invested 26 years ago would be worth £205,200 now (on average).

    I think fees of £7000 per annum and debts of £36,00 will certainly put students off university. And I think they should put students off. (Taking 9% out of your income for 30 years sounds appalling to me and considerably worse than a 2% rise in income tax.) Drastic shrinkage of the University sector may occur, but may be the best outcome of the present proposals, though one vigorously denied by the proposers.

    I hate the idea, however true, that a medical degree is a means to grow rich. It has already had a disastrous effect on the profession, for it has bred a generation of doctors with a very mercenary outlook (mixed in with, and corrupting, or depressing, the genuine philanthropists). I do not know who to blame for this trend, though I have some preliminary culprits in mind; everyone who has ever said "Get real!" for a start; for should we not rather say "Get ideal!". When I find the culprits I have a great load of  'scorn' to pile on them.

    The notion that a degree is valuable to society is as much in need of qualification as the other notion (that it is a means of making money). It should be a very simple matter for a committee to decide which degrees are valuable and which not. Indeed, it could be left to market forces, or so it will be argued, though the great debate between the "free-marketeers" and the "planners" did not end with the collapse of the Berlin Wall, for we are now sending spies to Scandinavia to find out why their banks are solvent, their pensions funded in perpetuity, and their citizens living contentedly with >50% income tax. What we principally need in this country are more waiters, bus-drivers, and plumbers. We seem to be overstocked (even to 30-fold) with psychologists, media students, and those hoping to improve water quality by looking at river wildlife. (Gambling bankers contribute nothing, except tax.)

    None of which reflection gets us very far forward, so here is a positive thought. Pehaps we should encourage businesses, and government departments who need graduates, to recruit school-leavers and sponsor their university studies, as was done on a small scale in the sixties and seventies of last century; I mean pay the tuition fees. I do not think I would take a university course under Mr. Browne's proposals unless I were sponsored in this way, and I would not urge any child or grandchild of mine to do so either.

Occidentis, MORPETH, UK.